Accumulate Big - Slow and Steady !!!
It's common sense that is the least common of things you get to see.
“In essence, you make your choices, and then your choices make you. Every decision, no matter how slight, alters the trajectory of your life. Every choice’s compound effect is in action all the time. Your life today is a result of your past choices. Hard choices, easy life. Easy choices, hard life.” - Gautam Baid
I am certain that the readers of this blog would have heard or read about the importance of compounding umpteen times already. But I still would assert that it’s not the default choice for most. If it was, you would see a lot more people at the gym 😀
So let’s look at the compounding formulae in the most basic manner possible #
In this formula, we relate Compounding to the subject of Wealth wherein A refers to the Outcome, P refers to the Input, R refers to the Rate of Return and N refers to the No. of Years you could get this R.
Looks simple, but let’s dig in !!!
In this formula, a higher A is the main objective. A higher capital at your end provides you status, provides you the comforts, social security, a better lifestyle, freedom to make choices, world travel, medical care for family, better quality child education, ability to pursue hobbies and so much more.
This is a no-brainer and has been pounded hard in our minds since childhood that success looks like this and we got to make this happen. At least in India, in Mumbai, where I come from, this message is passed onto us loud and clear. Add to this the aspirations created by exposure from movies/shows/social media that showcases/flaunts this kind of lifestyle which is accessible to the ambitious and the successful ones.
So the importance of “A” in the formula has been etched in stone.
But what gets missed out are the other variables i.e. P, R & N. These ain’t talked about or drilled in our minds as hard as A. These ain’t as sexy as talking about A, these don’t create the dopamine release that fantasizing about A does, these ain’t even pleasant as dreaming of A is.
Anshul Khare once aptly remarked, “In the initial years…compounding tests your patience and in later years, your bewilderment.”
Let’s look at P (the input) #
“P” refers to the money you put to work. But for putting money to work, you need to either earn more, which would require longer hours at work, or long hours to upgrade your skills so your work earns you more for the more skills that you bring to the table. Longer hours at work or skill upgrades mean lesser hours to watch Netflix, be Messi on Playstation, chill at the new discotheque, and few more silly sacrifices.
The sacrifices are silly but the inconvenience of dealing with your friends is the killer. Saying NO to them, or seeing their High Res images at the beach club, being taunted and sometimes ignored by them is what needs a stomach to digest the FOMO that comes along with this choice.
Alternatively, you could choose to stay with your current income and resort to frugality i.e. you could spend less, save more, delay gratification today by not spending on fancy things today, avoid spending on iPhone 15S, and make most of your iPhone 8S, avoid owning a sports car and enjoy your Japanese sedan.
These are choices too but these come with the inconvenience of not getting to gratify yourself today, looking relatively poor today, looking tacky using a 3-year-old version today, not getting to be the people magnet today, not getting to be at the fancy parties today. Basically, today of yours may look like ‘It Sucks’ for many others watching you live your choices.
Whichever choice you make, these could increase your P, the input. Both are painful in the short term, but it increases the P. And the more the P put to work, the more the A you could accumulate, and get much closer to your goals that is the whole point of all the work after all.
I’d like you to watch Rahul Dua’s journey as a comedian and what all he had to do so that his goal of becoming a comedian comes true. Everything he shares in this video is about increasing the P i.e. the input. It is money he needed to allow him to pursue his passion and also the time put in to upgrade his skills.
Let’s look at R (the rate of return) #
How much do you think a USD 10,000 saving can amount to if left to compound for 30 years with R at 7%, 9%, 11%, 13 %, and 15%?
@ 7% - USD 76,122
@ 9% - USD 132,676
@ 11% - USD 228,922
@ 13% - USD 391,158
@ 15% - USD 662,117
So the range of outcomes can vary from USD 76,122 to USD 662,117, depending on the R you get on your Savings/Investments . So R matters, ONLY & ONLY, if it has a longer term N i.e. R gets better with a bigger N.
But a bigger N requires patience and patience isn’t a sexy thing, it rather is a boring, dull, uncle type thing that doesn’t give you the kick you so crave. And hence the hunt for a higher R, which is where many behaviors enter your life i.e. over trading, speculating, betting, FOMO induced investing, buying on Tips, gambling, and more.
If you do understand the R in these cases, it could go as high as 1000% in 1 week and that calls for a feast and a party 🎉, that is if you get to be that lucky fool whose coin toss resulted in 10 heads in a row. This is purely out of luck and not something you can plan for. But the R can go to 0 too, or close to 0, which is capital ruin and a complete exit from the possibility of compounding that lost capital.
Just look at the Gamestop stock, the talk of the entire Fintwit community, news broadcasters globally, and even your circle of friends would have spoken about it. I am part of a Whatsapp group with all my CFA batchmates there and I saw messages there with a few flaunting the gains they made on the short squeeze on $GME. But how about the guy who got in at the top and saw his capital being wiped out 84.92% in less than 2 weeks.
Losing 85% means, your capital is reduced to USD 15 from the USD 100 you had invested. Now for you to get back or earn back the USD 85 that you lost, you need an investment that will grow your USD 15 six times over i.e. 6 Bagger in Investing parlance. This is an investment with 600% gains and you ain’t gonna get it from a quality company trading at elevated levels already since the whole world realizes the goodness of being invested in Google/Microsoft/Apple. And hence you may again get seduced into making a risky bet to earn that USD 85 back.
“In trying to make sense of this pessimism, Ridley, like Kahneman, sees a combination of cognitive biases and evolutionary psychology as the core of the problem. He fingers loss aversion—a tendency for people to regret a loss more than a similar gain—as the bias with the most impact on abundance. Loss aversion is often what keeps people stuck in ruts.” - Peter H. Diamandis
This is how you explain the addiction of a degenerate gambler. He just can’t make peace with the loss and hence continues the gambling till he may lose it all. You can see a lot of that in investing too. You chase a high return because that’s what your friends are earning by investing in Dogecoin, or Space SPAC, or a new age Biotech company, or Call Options on $GME or other meme stocks, and more, but your missing the point that there is a possibility of the ruin of capital wherein the R can go to 0 and turning your way back from there becomes extremely difficult.
There is a very fundamental tradeoff between R & N. You can either have a higher R but at the cost of a lower N or you could have a slightly lower R but for a longer N. But you can rarely get a very high R and a very high N but unfortunately this is what most are chasing.
Hence Warren Buffet always says “Rule number 1: Never lose money. Rule number 2: Never forget rule number 1.”
I’d like to have the founder of Social Capital, Chamath Palihapitiya share with you the essence of this trade-off #
It’s the N in the formula that holds the key to you achieving the A you so desire. Putting in the P only for a short term isn’t gonna do miracles for you. Earning high returns only for the short term isn’t gonna do it for you. But if you are willing to compound your capital, slowly but consistently, then and then alone do you have a shot at having all your financial As in your grasp.
If Amazon was your pick in 2001, then it has compounded at the R of 32% for 20 years i.e. USD 10,000 invested in 2001 would have turned to USD 2,579,162.
If TCS India was your pick in 2001, then it has compounded at the R of 18% for 20 years i.e. USD 10,000 invested in 2001 would have turned to USD 273,930.
If Berkshire Hathaway was your pick in 2001, then it has compounded at the R of 8.77% for 20 years i.e. USD 10,000 invested in 2001 would have turned to USD 53,725.
Irrespective of the choice of your asset, if it is a business that keeps growing and you have done your due diligence on the same and the runway ahead, then giving it time to compound is the smartest thing you can do. Interrupting it because you ain’t excited or overtrading just because you are bored with the time at hand, is plain and stupid.
This ain’t just a mathematical concept, it is a mental model and is applicable to everything else too i.e. goodwill, reputation, health, virus, relationships, etc.
Let’s look at Goodwill #
Yesterday’s Gulf News covered a story that exactly illustrates the interruption in N due to chasing a higher R. A DIFC Banker assists a client in money laundering by opening an offshore entity in his name and facilitating the transactions that were not permitted or within the framework of the DIFC guidelines.
Just think of it, a Senior Banker with decent success in the industry, with the privilege of representing a reputed Swiss Firm and enjoying the perks that come along - why would he indulge in an activity that has shades of grey and massive risks. It is simply a higher R since the hedonic treadmill of life doesn’t allow us to enjoy the fruits of our labor after we have attained it. The thrill comes from the pursuit of many As quicker and hence one has to be mindful of not being seduced into a higher and higher R since that could compromise the N ahead of you.
It sometimes feels like REPETITION has gained a bad reputation i.e. it’s boring, it’s not exciting, it ain’t great, it doesn’t make a good story, and more. But if you look into any success story, it is simply a story of repetition of a trait and a skill for years to eventually accumulate into a story to write about
The above illustration of Warren Buffet’s trait is what makes him the legend he is. Some of you might be bored of me mentioning his name time and again, but the reason I do so is that he has consistently held on to his character of frugality, the skillset of buying only when the time is right, not risking capital ruin and playing a long term game while sticking to ethics and integrity. This is a lethal mix of essentials and hence no wonder, he is worth USD 80 billion and counting.
His life is COMPOUNDING at it’s best, at least for me. And more than Wealth, it’s the Goodwill he has amassed by being the role model he has been for so many money managers worldwide. I rarely hear a podcast or read an article/book by the greatest in our business without a mention to Warren Buffet or Charlie Munger.
Let’s look at building a Community #
The following video illustrates how compounding plays out when you stick to being authentically you, instead of wearing a mask that others want you to wear.
Just being yourself is also a rare commodity today. You say YES when you want to say NO, you say NO when you want to say YES, you do what you see others do, you opine on basis of how well your opinion is being received, you don’t express when you should have, you ain’t willing to have the difficult conversations, you ain’t willing to cut the toxic people out, you ain’t willing to go through pain in the short term for results in the long term. When I say You, I mean everyone else but you 😀
But, if you stayed authentic, you will surprise yourself with the community you will build around you, the loyalists , the followers, the well wishers, the fan base - all comes to you with no cosmetic or marketing effort on your part. You become a people magnet because your authenticity attracts people who would like to hand around, listen and learn from someone who isn’t bullshitting, which by the way is a lot of what’s going around today. Coincidentally, the book I am currently reading is also titled the same 😉
Let’s look at Social Distancing / Lockdowns / Quarantine #
The only reason for these measures is to bring down the rate of R in the multiplication of the COVID19 strain. Bringing down the R, brings down the accumulation of A i.e. higher no. of infected people. Lower the A goes in this case, higher the N goes in the hands of the Medical fraternity to come up with effective vaccines and the adequate amount of doses. We can call this ‘Reverse Compounding’ in effect.
Come to think of it, everything you do, or choose not to do, is either facilitating the compounding effect in your life or interrupting it unnecessarily.
To summarize the message, let me share what Li Lu has to say about the concept #
When two people exchange knowledge, they learn more than just what the other is thinking; their meeting will also create the sparks of new ideas. The sharing of knowledge requires no exchange like trading corn for milk. But when you combine knowledge you begin to see growth happen in large increments thanks to the benefits of compounding. Only when each exchange can produce such large incremental benefits will society be able to speedily create wealth. This kind of continuous inter-personal exchange multiplied billions of times created the modern free market economy. And this is Civilization 3.0. Continuous, sustainable economic growth is only possible with this kind of exchange. This kind of economic system is the only way to fully release mankind’s energy and true motivations. This system is probably the greatest innovation in the history of mankind
I took classes from Kaplan for CFA, the main reason was to build a network of people who are striving to get better in the world of Investment Analysis. I am looking forward to attending the 5 day Value Investing Workshop at Flame University, India. More than the lessons learnt, it is the community of analysyts/aspiring analysts I am intending to interact with. I am also attending a Part Timer Youtuber Academy Course by Ali Abdal that begins on 15th Feb. It’ll be a fun experience to learn from a community of 200 aspiring Youtubers from across the globe and ofcourse the facilitator himself.
I am not sure what opportunities will open up with these endeavours but every experience and relationship has the potential to compound into something beautiful. It will either give you a new friend, a new learning or a new skill to exploit for economic gains in time to come.
It’s simple, but not easy. It’s short term pain, but long term gain.
“Understanding both the power of compound interest and the difficulty of getting it is the heart and soul of understanding a lot of things.” —Charlie Munger
Wishing you loads of love and luck.
Manish